2. Spatial Transactions Costs

Apart from institutional tariff barriers, the international spatial transactions costs faced by firms are primarily of two types: international transportation costs and international information transmission costs. In this section we will review the developments and changes in each of these two types of transactions costs in order to understand the transactions costs environment faced by New Zealand firms which competing in international markets.

2.1 Information costs

Since the 1980s we have seen dramatic improvements in the ability of decision-makers and planners coordinate activities across space. The primary reasons for these improvements have been the enormous technological developments in information technology, and also the advent of widespread usage of these technologies. These developments have meant that complex operations can now be managed both more efficiently and effectively than was previously possible. There are two aspects to these developments.

Firstly, the new information technologies have reduced the real costs of communicating across distance, allowing us to more efficiently control existing spatial arrangements of activities (The Economist 1999a). This is a common observation in industrial sectors and activities where physical commodities are being moved across large distances, such as in the management of international importing and exporting supply chains (Financial Times 1999b) or the coordination of multinational manufacturing activities (The Economist 1999a). Analogous arguments also exist for the case of the service sectors, in situations where information rather than physical goods is being transferred across space. In many situations, information technologies employing satellite and fibre-optical technology allow for greater quantities of information to be transmitted at a much lower costs than was previously possible.

Secondly, the existence of these new information technologies also allows decision-makers to undertake the coordination of spatial arrangements of activities which were previously not possible. This is evident in examples such as international accounting, where New York banks transfer their book-keeping requirements overnight to firms in Dublin, in order to have them updated in time for the opening of the money markets the next day. Other examples include Silicon Valley firms which subcontract software development activities to firms in Bangalore India, while still maintaining daily contact and control of the Indian software development process from California. Meanwhile, for service industries such as finance and marketing, the new possibilities provided by information technologies for the supply of information-based services across global space appear almost unlimited (The Economist 1999a).

The reductions in the real costs of transmitting information across space, which are associated with these new information and communications technologies, would suggest that geographical peripherality is becoming relatively less of a handicap to accessing international markets. From the perspective of New Zealand, such observations would appear to be beneficial, as they imply that any adverse competitive effects associated with geographical peripherality will have fallen over time.

On the other hand, however, there are some other arguments which suggest that over time the development of these information technologies is actually leading to increases in the costs of transmitting information across space, thereby increasing the relative importance of geographical centrality. The argument here is that an increase in the quantity, variety and complexity of information produced, itself increases the costs associated with transmitting this information across space. This is because much of the information will be of a non-standardized tacit nature, and the transmission of this type of information essentially requires face-to-face contact. Examples of this phenomenon are common in industries such as international merchant banking, where the complexity of many new financial products requires highly complex negotiations to be undertaken in order to guarantee their provision (Cohen 1998). The opportunity costs involved in not having face-to-face contact will consequently increase with the quantity, variety and complexity of the information produced. The effects of this will be to increase the costs of doing business across large geographical distances. As such, these arguments would suggest that geographical peripherality may become progressively more of a handicap to business growth due to the increased relative costs of distance. These latter arguments do not favour New Zealand.

2.2 Transportation costs

As we suggested at the beginning of this paper, transportation technologies have improved dramatically over recent years. Obvious examples of this include the growth in roll-on roll-off trucking, containerisation, rapid-turnaround shipping, and the increased efficiency and frequency of airline services. As with information transmission, the reductions in the real costs of transporting goods associated with these new technologies would suggest that geographical peripherality is becoming relatively less of a handicap to accessing international markets. Once again, from the perspective of New Zealand, such observations would appear to be beneficial, as they imply that any adverse competitive effects associated with geographical peripherality will have fallen over time.

On the other hand, the quantity, variety and complexity of market information generated in the modern economy is increasing. This also implies that in many industries which involve the production or shipping of goods across space, the variety and complexity of the logistics operations being undertaken will also increase. The reason for this is that as modern consumer demand requirements become more sophisticated, there is an increasing preference for goods shipments characterized by speed, reliability and timeliness. In other words, the consumer’s opportunity costs of time have also increased for goods shipments.

Modern household and industrial consumers now require a level of service customisation and delivery speed, which previously was not considered either so important or even possible. As the demand for delivery speed increases, the associated opportunity costs of lead-times also increase, and the average inventory levels maintained will fall. The effects of this on distance costs can be explained by adopting a similar argument to that employed above. For any two agents at a given distance apart, the optimised delivery frequency increases as the opportunity costs of time increase.[1] Analytically, the effect of this is to increase the transactions costs associated with shipping goods over any given distance. The spatial outcome of this argument is that potential customers and suppliers will tend to move closer to each other as the variety and complexity of market information increases.

The most extreme example of this trend towards more frequent shipments, is the application of Just-In-Time (JIT) manufacturing and distribution techniques, the influence of which has pervaded all areas of modern production, distribution and retailing. New information technologies allow firms to coordinate logistics activities across huge geographical areas in a very sophisticated and timely manner. In the new JIT production and distribution arrangements (Nishiguchi 1994; Schonberger 1996), it is necessary to control the flows of goods between firms to a very high degree, in order to ensure the timeliness of deliveries. The ability to track and monitor the speed of movements of goods therefore becomes essential, particularly if the goods are being shipped over significant distances.

Similar arguments also hold for the case of customized high-speed mail services. Yet, these technological developments have also lead to a change in consumer behaviour. Both household and industrial consumers now expect goods to be delivered JIT. As such, the nature of demand for transactions across space has changed dramatically. Customers now require much shorter lead-times than was previously possible, and the spatial effect of this is to encourage potential suppliers and customers to move closer to each other.

There is a range of empirical evidence which suggests that the spatial transaction costs involved in shipping of goods have indeed increased over the last two decades, because of this demand for more frequent deliveries. Firstly, the average inventory levels for almost all manufacturing and distribution sectors in the developed world have fallen dramatically since the 1980s, relative to the value of output (Shonberger 1996; Financial Times 1998). This implies that the average lead times of goods-shipments have fallen over recent years, with a concomitant increase in goods-shipment frequencies. Secondly, by carefully disentangling the various components of transport costs it becomes clear that the proportion of global output which is accounted for by logistics and transportation activities in the economy has not fallen over recent decades (Hummels 1999; Financial Times 1997). Thirdly, while the transportation cost component of bulk materials has indeed generally fallen, in the case of manufactured goods, there is evidence that this proportion has actually increased over the recent decades, in spite of the improvement in transportation and logistics technologies (Hummels 1999). Fourthly, industries which are very dependent on JIT shipments have tended to reorganise their trade patterns in favour of geographically close suppliers and customers (Reid 1995; McCann 1998). Moreover, this behaviour is even evident in industries in which the product value-weight ratios are extremely high (McCann and Fingleton 1996). In other words, such localization behaviour is present in the very industries which traditional Ricardian trade theories would have ruled out.

2.3 Changes in international transactions costs

Glaeser (1998) argues that taking a broad view of all the empirical evidence indicates that the aggregate share of total output accounted for by transportation costs has fallen markedly over time. If we follow the straightforward technological arguments outlined above which suggest that information transmission costs and international transportation costs have both fallen over time, we could also conclude that geographical peripherality is becoming much less of a competitive disadvantage for accessing international markets than it might have been previously. This is because the supply of activities, goods or services will become progressively cheaper and easier over greater spatial scales, due to better management and delivery possibilities provided by the new transport and communications technologies.

These reduced costs of doing business over large geographical distances also imply that the range of activities supplied across all spatial areas will tend to converge. The reason for this is that a general reduction in spatial transactions costs will reduce any missing markets associated with transactions costs inefficiencies. As such, the advent of these new transport and communication technologies suggests that international differences in geographical location would appear to become successively less important over time in determining the range of products and activities available to any particular country. Some authors have even assumed that eventually this would lead to the death of geography as an issue in its own right (Toffler 1980; Naisbitt 1995).

On the other hand, however, as we have seen here, there are also arguments which suggest that the development of the information technologies themselves is actually leading to increases in the costs of doing business across space. Information technology alone obviously reduces the costs associated with transmitting particular quantities and types of information across space. However, an additional aspect of these technologies is that they also lead tend to lead to an increase in the quantity, the variety, and the complexity of the information and goods being transported across space.

As the quantity, variety and complexity of the information being produced increases, the question arises as to the nature of the costs involved in transmitting this increasingly complex and varied information across space. At issue here, is the question of exactly how we define geographical transactions costs. When considering the costs of conducting business over large geographical distance, it is essential to consider both the costs involved in transporting both goods and information across space, as well as the opportunity costs involved with lower frequency business interactions.

The preceding sections provide a range of arguments and evidence which suggest that the real costs involved in transacting information and goods across space have both decreased and increased over recent decades. However, these apparently conflicting conclusions can be reconciled in that the different types of changes in transactions costs described above have tended to take place in different types of sectors and activities. Taking a broad view of the issues, it appears that most of the evidence points to falling international and geographical transactions costs for existing types of activities.

The sectors in which spatial transactions costs have indeed fallen significantly over recent decades, are generally the sectors in which the nature of the spatial transactions undertaken have not changed fundamentally over time, in terms of the required frequency of interaction. This is typically the case in many raw material, agricultural or extraction industries, and in industries producing manufactured products at a mature stage within their product cycles (Vernon 1966). This is also the case in service sector industries in which the nature of the information being transacted is rather standardized, such as retail banking. In other words, where the nature and characteristics of the transactions have not changed, then international transport and transactions costs have fallen steadily over time. In these cases, geographical peripherality would appear to be less of a disadvantage than it might have been previously.

On the other hand, in production sectors in which the demand lead-times have fallen dramatically, or in industries in which the variety and complexity of information generated has increased significantly, spatial transactions costs would appear not to have fallen over recent decades, and in some cases will actually have increased. Where such costs may have risen over time, it appears that this is a result of the fact that the nature and characteristics of such transactions have changed, thereby violating the ceteris paribus criterion. In these cases, the requirement for geographic proximity would appear to have increased, and the potential disadvantages of geographical peripherality would appear to have increased.

In the following sections we will distinguish explicitly between these two types of effects; one which acknowledges falls in existing standardised types of international transactions costs, and one which allows for cost increases associated new types of spatial transactions costs. As we will see in the remaining sections of this paper, it turns out that transactions costs have tended to decrease for most international transactions, while transactions costs have tended to increase for transactions which are primarily contained within the geographic area of an individual country.